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REVERSAL


Short-Term Pattern: Adam And Eve

10/24/05 10:32:39 AM
by Paolo Pezzutti

This pattern provides big profit opportunities when the reversal occurs at the end of parabolic rallies.

Security:   XRX, LU, ADBE
Position:   N/A

According to Thomas Bulkowski's Encyclopedia Of Chart Patterns, the Adam and Eve formation is characterized by a sharp and deep first bottom on high volume (Adam). The stock bounces and develops a more gentle correction, printing a second bottom (Eve) on lower volatility. Eve's rounded bottom takes longer to develop than the Adam spike and it is characterized by lower volumes. Price action congests into a tight range and the stock then breaks to the upside. The top of Eve marks an excellent entry point when broken. The resistance is often located along the top of the center retracement pivot. Sometimes they occur at the end of parabolic rallies. The opposite is true when the Adam and Eve formation identifies a top. Risk must be managed very carefully. Sometimes you might conclude that a bottom has been reached, only to discover that it's a breakout to new lows. Further, stop-losses must be applied with discipline. Don't stick around too long; the failure of this pattern will gain downside momentum quickly. Entry is not easy from the psychological perspective, because sentiment will be negative during this type of market action and volatility will be high. The potential for short-term profits is high, because the reversal, when successful, is explosive.

Let's see the Adam and Eve pattern in action.
In Figure 1, you can see an Adam and Eve top formation on Xerox (XRX). At the end of a rally, prices print a spike. That is the end of the up movement. Buyers' determination to bring prices higher has been burned in one only session. Eve is developed on lower volatility.


FIGURE 1: ADAM AND EVE TOP FORMATION, XEROX. Note the Adam spike at the end of a parabolic rally.
Graphic provided by: TradeStation.
 
In Figure 2, you can see a very nice example of an Adam and Eve bottom. This is the end of a long downtrend for Lucent (LU). Note that after the Adam low, which occurred with prices accelerating to new lows, the Eve bottom develops with smaller-range bars. The breakout to the upside is explosive.

FIGURE 2: LUCENT. Here's an Adam and Eve bottom at the end of an impressive downtrend. Prices print an explosive reversal.
Graphic provided by: TradeStation.
 
In Figure 3, you can see an excellent formation of Adam and Eve bottom. Adobe (ADBE) printed an impressive downtrend in April 2005. The stock lost 20% in six sessions. The Adam bar printed also an exhaustion gap. Eve developed in the form of an a-b-c correction, followed by a tight congestion. Prices then moved up, breaking out the retracement pivot very fast.



FIGURE 3: ADAM AND EVE BOTTOM, ADOBE. Eve is printed in the form of a long correction.
Graphic provided by: TradeStation.
 
This is another formation for your short-term library of patterns. When you look for this formation at the end of rallies, the profit potential is high. The environment is very volatile, and there is the possibility that prices during the Eve formation test the Adam low/high before completing the reversal. Watch out: Pattern failures will bring big losses if the stop-loss is not applied with discipline.



Paolo Pezzutti

He is the author of the book "Trading the US Markets - A Comprehensive Guide to US Markets for International Traders and Investors" - Harriman House (July 2008)

Rome, Italy
E-mail address: pezzutti.paolo@tiscali.it

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Date: 10/24/05Rank: 4Comment: 
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